This posting is from D&S collective member and frequent blogger Larry Peterson. To see more of his posts, click here.
Well, the “plan,” such as it is, is finally on the table. A three-page document outlines the Treasury Department proposal, hints of which set markets worldwide skyrocketing late Thursday and into Friday, to buy as much of the questionable (to put it politely) assets held by private banks, investment companies and insurers as is necessary (up to $700 billion, anyway; after that, Treasury will have to go to Congress for a top-up) to get banks–spooked by the pile-up of potentially toxic assets into hoarding cash with an abandon not seen since the days of the London Blitz–to each other again. Indeed, talk now is that foreign banks will be invited to sell their dud loans to the American taxpayer as well. Next week the plan will go to Congress, where legislators must amend and approve it by the end of the week, as well as expanding the budget deficit ceiling to account for all the new government borrowing. Otherwise they (many of whom face re-election) will go home to their constituencies with nothing to show for their efforts. Lobbyists are swarming all over the Washington trying to influence the outcome (with campaign cash that will no doubt be even more enticing to lawmakers in the waning days of their campaigns than it ordinarily is).
The basic plan is three-fold (only the first of which is directly addressed in the proposal): first, as mentioned above, it gives Treasury (in the person of the Secretary) unprecedented powers to purchase mortgage-related assets, and also the funding to do so, up to $700 billion. The second part involves short-selling: this practice (in which shares in companies that are expected to underperform are borrowed, sold into the market before they fall in value, and then bought back on the market after any price fall, with proceeds kept by the short-seller before s/he returns the shares borrowed), which has been used by many big investors, like hedge-funds, to capitalize on the difficulties of the financial firms that we’ve seen threatened–or even disappear–over the last few months, has been effectively banned. Finally, money market funds (previously considered safe as cash, though without a guarantee, and which were coming under pressure last week, seeing large redemptions) will be guaranteed along the lines of bank accounts, with deposit guarantees.
As the Financial Times notes, these measures will complement historic supports already put in place to expand the activities of the mortgage-lenders Fannie Mae and Freddie Mac, as well as to keep the insurer AIG solvent.
So what we have here is the following: the US taxpayer will buy dodgy loans that private firms wouldn’t be caught dead buying, from firms which have been hoarding cash in the fear that they’ll (as they should be, in many cases) be on the hook for the losses. This, it is hoped, should have the effect of freeing up that cash, which the firms should make available to potential borrowers, rather than hoarding. This should cause demand for good assets to rise, increasing their prices to such an extent that even loans associated with the duds may come to be seen as bargains, especially if, with the passage of time, many are found to be, in fact, untainted. This will allow the mortgage market to recover, along with it a newly invigorated–and, presumably, highly re-regulated–financial sector and this will ensure recovery for the US economy, even in the face of the job losses, prolonged weakness in demand, and far higher debt the program will invariably cause.
What are we to make of this plan? The biggest flaw to my mind concerns the attempt to re-start the mortgage market. This market is still, in many ways, overvalued, and any attempt to create a floor for it seems fundamentally misguided. This is all the more so when one considers that potential consumers will be offered neither the indiscriminate loan availability nor super-low, indeed nonexistent initial interest rates (partially as a consequence of all the government borrowing that’s going into the bailout) that enabled much of the home price appreciation that so madly overshot the bounds of sustainability between 2004 and 2006, and still remains in that territory; and the fact that wages are expected to be stagnant (at best, given the persistently rising levels of unemployment), in the face of rising or continued-elevated general consumer price levels, and the delivery of less benefits and social services as public coffers are depleted by bailouts and the implementation of automatic stabilizers to deal with economic downturn, makes the suggestion even more unrealistic. In addition to this (as if anything else were needed), the administration has been far less active in coming up with measures that will help present mortgage-holders hold on to their homes in the face of a major economic downturn. So relief on this front cannot be expected for several months, during which time many more homes may be thrown back on the market, depressing prices. And these developments will increase the already heightened fears that US commercial and regional banks will fail, due to nonpayment of credit card and other debt, assuming all the mortgage debt is absorbed by the government.
And we still don’t know the extent of the mortgage-related losses; not by a long shot. If they keep piling up, especially assuming the measures to create a floor for mortgage debt don’t work, the cost to the taxpayer, already struggling with higher unemployment, and even to corporations, which are seeing their unrealistic profit levels of the bubble years come back to earth, will become even more of a burden, which, in true American fashion, may be foisted on foreign lenders. But many of these countries are following the beleaguered US consumer by retrenching as global growth slows, so their willingness to absorb this debt can no longer be taken for granted. And any pullback in this regard could re-ignite the inflation we’ve all so effectively forgotten about.
The second objection I have concerns the short-selling ban. I’m not exactly sympathetic with short sellers on a class basis, needless to say, and resent mightily the privileges regarding leverage, taxes and so on which they’ve amassed through the years. But, as Anatoly Kaletsky has written, the attack on short sellers has been in this case totally misdirected, and has ended up hurting potential longer term investors as well as leading to the crisis has resulted in the burden being foisted on all the rest of us. In addition, the fact that many of those who have complained so vocally about short-sellers in the last few weeks have made quite a bit of money in fees serving as prime brokers to them gives us yet another example of how surreal this crisis (and our economy) has become.
One last word before summing up: in one of his characteristically incisive and timely posts, Yves Smith cites the following, highly disturbing contribution from one of her readers:
I worked at [Wall Street firm you've heard of], but now I handle financial services for [a Congressman], and I was on the conference call that Paulson, Bernanke and the House Democratic Leadership held for all the members yesterday afternoon. It’s supposed to be members only, but there’s no way to enforce that if it’s a conference call, and you may have already heard from other staff who were listening in.
Anyway, I wanted to let you know that, behind closed doors,
Paulson describes the plan differently. He explicitly says that it will buy assets at above market prices (although he still claims that they are undervalued) because the holders won’t sell at market prices. Anna Eshoo pressed him on how the government can compel the holders to sell, and he basically dodged the question. I think that’s because he didn’t want to admit that the government would just keep offering more and more.
In summary, then, it’s been an extraordinary week: in the history of finance, it’ll have to go down as a kind of “fall of the Berlin Wall” affair. A financial regimen that enjoyed unparalleled sway over much of the earth for a generation has been destroyed by its own contradictions and the abuses it built into itself. Unlike the fall of the Wall, however, there is no liberation to celebrate, and we certainly cannot be confident in the political situation to the extent that we can assume that, even in the long run, something better will come out of the situation.